Retail Results Signal Tough Times Ahead

Despite big discounts, pressured shoppers cut back on spending during the holidays. And the new year may not be much better

Like a football team that's played a quarter or two too many, consumers are finally showing signs of folding under pressure, based on initial results of the Christmas shopping season. And with gas prices creeping back up and home prices in a slump, retailers have every reason to worry about 2007.

Despite deep price cuts from big discounters such as Wal-Mart Stores (WMT) and round-the-clock shopping hours at some department stores and malls as Christmas approached, holiday retail sales have fallen short of expectations—up 4.3% so far this season, short of the 5% forecast, according to initial estimates released Monday by ShopperTrak RCT, a Chicago-based researcher that tracks retail sales.

Even though bargain hunters hit the stores the last two weeks before Christmas, it was hard to beat the sales of Black Friday, the day after Thanksgiving, when consumers spent $8.96 billion. The second-highest shopping day was Saturday, Dec. 23—so-called Super Saturday—when sales totaled an estimated $8.72 billion. "It's possible that consumers may have responded to the anticipated large crowds and taken pains to avoid crowded malls altogether," says Bill Martin, co-founder of ShopperTrak (see BusinessWeek.com, 11/15/06, "Wal-Mart: Back to Basics for the Holidays").

No Discount Deep Enough

Retailers have immediately shifted into post-holiday mode, with some sending out e-mails touting post-Christmas sales even before holiday dinners were served in most recipients' homes. But it may be too late to recover. Wal-Mart said it was expecting sales to be flat to up 1% in December, after posting a 0.1% decline in November sales, its first drop in 10 years. The downturn came despite some of Wal-Mart's deepest discounts in toys, home appliances, and electronics, and it countered retailers' preseason optimism for a thriving shopping season (see BusinessWeek.com, 11/2/06, "Forecast: A Very Happy Consumer Holiday").

Many economists see Wal-Mart's sluggishness as a sign that the low-income spectrum of the economy is hurting because recent jobs and income growth have favored the middle- and upper-income segments of the population. A report released this month by the National Low Income Housing Coalition found that the increase in the cost of modest rental housing in recent years has far outpaced that of the wages of minimum-wage earners. "Wal-Mart's core shopper is clearly under strain right now and will remain vulnerable as we go into the coming year," says Frank Badillo, vice-president and senior economist with Retail Forward, a retail strategy consulting firm based in Columbus, Ohio.

As gas prices at the pump start sneaking back up, low-income consumers will be under even more pressure. On Christmas Day, unleaded gasoline averaged $2.34 a gallon nationwide, up 10¢ from a month ago and 15¢ higher than a year ago, according to AAA. And Badillo expects higher fuel prices to have a heavy impact on lower-income spending. And job growth is coming at a price in some sectors, which could also hurt future consumer spending. Economist Brian Bethune at financial analytic firm Global Insight points out that the average wage of jobs at a Japanese automaker in the U.S. is 30% lower than a similar job at one of the Big Three automakers. "So jobs are being created, but they are lower paying and that affects spending," says Bethune.

Some Relief for Upscale Retailers

But Badillo notes that as upper-income households benefit from job and income gains, it will likely give some relief to upscale retailers, which had torrid sales during the early part of the holiday season—Saks (SKS) reported a 7.2% gain in November same-store sales and Macy's and Bloomingdales' operator Federated Department Stores (FD) saw an increase of 8.9% and even raised its December sales forecast (see BusinessWeek.com, 11/22/06, "Customer Service Is Back in Style").

However, not all retailers who cater to higher-income shoppers are likely to do well. Consumer electronics stores, which have catered to a more upscale clientele, are already hurting this holiday season as flat-panel TV prices fell 40% in the last two months of the year. Circuit City (CC) reported a third-quarter loss, and Best Buy's (BBY) third-quarter profits fell short of Wall Street's expectations, rising 9%, after both were forced to slash prices on flat-panel TVs. "Even those in the upper income want to be perceived as wise shoppers," says Robert Passikoff, president of New York consultancy Brand Keys.

As the housing slump continues, furniture and home-improvement stores will be under even more duress. Already people are cutting back on home furnishings and big-ticket appliances such as washing machines, hurting results at the big-box home improvement stores such as Home Depot (HD) and Lowe's (LOW). Until housing prices stabilize, it's unlikely that retailers that supply homes will reap big gains. Which means, for many retailers, 2007 may start with a hangover that will take a long time to shake.